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What Is a Nonforfeiture Clause?
Let me explain what a nonforfeiture clause is: it's a provision in an insurance policy that ensures you, as the insured, can get full or partial benefits or a partial refund of premiums if your policy lapses because you didn't pay the premiums.
You'll find these clauses in standard life insurance and long-term care insurance policies. They might involve returning some of the total premiums you've paid, the cash surrender value of the policy, or a reduced benefit based on the premiums you paid before the lapse.
Key Takeaways
Remember, a nonforfeiture clause means you can receive benefits or refunds after a lapse due to nonpayment. These are common in permanent life insurance, long-term disability, and long-term care policies. For traditional whole life policies, you decide how to access the policy's cash value.
How a Nonforfeiture Clause Works
When you own a whole life insurance policy and decide to surrender it, you have several nonforfeiture options. The insurance company guarantees a minimum cash value after a specific period, usually three years from the policy's start.
For traditional whole life policies, you choose one of four ways to access the cash value. There are no guarantees for the minimum life insurance amount in variable and universal life policies, which involve variable investing. Also, the amount of reduced paid-up or extended-term insurance could decrease if the policy's sub-account performs poorly or if credited interest rates are low.
In permanent life insurance, if you fail to pay premiums during the grace period, you won't lose your coverage entirely. Instead, you can access your accumulated cash value through options like terminating for cash surrender value, reducing coverage with no future premiums (a paid-up policy), buying extended-term insurance with the cash value, or using the cash value to pay future premiums via an automatic premium loan.
If you don't select an option, the policy terms will dictate which one applies if the policy lapses or is surrendered.
Payout Options Under a Nonforfeiture Clause
After surrendering a whole life policy, the death benefit ends. Before paying you, the insurer satisfies any outstanding loans with the cash value.
Some companies include an annuity option in the nonforfeiture clause, where you can use the remaining cash value to buy an annuity without commissions or expenses, providing regular payments as per the contract.
Cash Surrender Value
With this option, you terminate the policy and receive the remaining cash value within six months. This applies to the savings element of whole life policies, payable before death. In the early years, the savings portion yields little return compared to premiums paid.
Cash surrender value is the accumulated cash value available upon surrender. Depending on the policy's age, it could be less than the actual cash value due to fees deducted in early years.
Paid-Up Policy
Here, you use your cash surrender value to buy a paid-up version of the same policy type, eliminating future premium payments. However, this reduces the death benefit, and the policy's cash value grows at a reduced rate.
Extended-Term Insurance
This option lets you use the cash value to buy a term insurance policy with a death benefit equal to the original whole life policy, calculated from your attained age. The term ends after a fixed number of years as per the nonforfeiture table. For some companies, this is automatic upon surrender.
Extended-term insurance means you stop paying premiums without forfeiting equity. The cash value is reduced by any loans. Often the default, it keeps the face amount but converts to a term policy, using equity to cover a term equal to years of premiums paid.
For instance, if you bought the policy at 20 and paid until 55, you'd get a term less than 35 years. If purchased at 35 and paid until 45, it's less than 10 years.
Policy Loans
Policy loans don't need repayment like conventional loans, but amounts taken reduce the death benefit for beneficiaries. You'll face interest from 5% to 9%, and unpaid interest compounds on the loan amount.
Why Do Nonforfeiture Clauses Exist?
These clauses protect you if you stop paying premiums. After a grace period, if cash has accumulated, state law prevents insurers from keeping it and canceling the policy.
What Is an Extended-Term Option?
This lets you use whole life cash value for term insurance, stopping premiums while keeping the original death benefit.
What Is Cash Surrender Value?
It's the savings element of whole life policies, the accumulated cash value available upon surrender, potentially less than actual value depending on policy age.
The Bottom Line
Understanding nonforfeiture options helps you pick what's best for your situation, whether extended-term, cash surrender, or another. Consider talking to a financial advisor for guidance on what fits your needs.
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